How To

How to Beat a Small Business Tax Audit

How to Run a Business

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by Matt Alderton |
December 06, 2012

You're probably busy celebrating Christmas or Hanukkah. You should know, however, that the taxman doesn't take a holiday. It's entirely possible, therefore, that you could wake up Christmas morning to find an IRS audit in your stocking.

If that happens, don't fret. There are steps you can take to help the audit go your way, says Bankrate.com contributor Kemberley Washington. "The IRS audits only a small percentage of tax returns," according to Washington, a certified public accountant. "But if your business is one of the lucky few, understanding the appropriate steps to take will determine whether or not your outcome is favorable."

Following are Washington's tips for beating an IRS audit:

• Prove you're a business: "According to the Internal Revenue Code Section 183, deductions are limited when an activity is not engaged in for profit," explains Washington, who says business owners must prove that their company is a business, not a hobby, which they can do by outlining their plans to increase profitability — for instance, with a marketing plan — and by providing evidence of profits in prior years.

• Claim missed deductions: "Many business owners may not know it, but an audit is also a great time to submit documentation for expenses not previously claimed on the tax return. If you discover you have overlooked certain deductions, you may be able to claim them," explains Washington. "A business can deduct expenses that are ordinary and necessary in carrying out the trade or activity. This is a great time to submit documentation for overlooked deductions. Such deductions may reduce the taxpayer's liability or possibly generate an overpayment of taxes, which can offset any deficiencies determined by the IRS."

• Be creative: "Just because your business may not have certain documents to substantiate expenses on the tax return does not mean all is lost," Washington says. "Keep in mind that the IRS allows for third-party documentation, oral testimony and other forms of verification substantiating expenses. For example, if a business lacks documentation to support business mileage reported on the tax return, consider using Google maps, clients' records and past invoices to estimate mileage traveled during the taxable year in question."